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Judging the Judges' Judgments

How will Obama's economic team influence the markets?

12:00 AM, May 1, 2009 • By IRWIN M. STELZER
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John Maynard Keynes once wrote that if you want to bet on which of several contestants would win a beauty contest, don't try to guess which girl is the prettiest. Instead, try to pick the girl that the judges will decide is the prettiest. So with the economy. We have to guess not only which green shoots, if any, are likely to grow into sturdy oaks, but what decision the judges--Federal Reserve Board chairman Ben Bernanke, Treasury Secretary Tim Geithner, and White House adviser Larry Summers, among others--will make about the durability of any emerging recovery. And what next steps they will recommend to the president.

White House and Fed officials are looking beyond the reported 6.1 percent drop in first quarter GDP from the last quarter of 2008--a year-over-year drop of 2.6 percent. They are digging into the component parts of the GDP total to see if they can sign on to the conclusion of economists at Goldman Sachs that the GDP report is "supportive of future growth despite the deep decline."

Here's the reason for that cheer. Consumption rose by 2.2 percent in the first quarter (although March was a bit weak) as consumers took $200 billion in tax refunds (up 30 percent over last year) and $100 billion in transfer payments to the malls. Still to come are a one-time $250 payment to all Social Security recipients, and the impact of the Making Work Pay tax credit, which will reduce taxes taken from pay checks of all workers other than "the rich" (workers earning more than $200,000 and families earning more than $250,000).

Remember: the consumption component of GDP is generally considered a lead indicator, or as the Goldman Sachs economists put it, "Stabilization of consumption normally leads an overall recovery." The increase in consumption might be a reflection of a jump in consumer confidence, which finally showed itself in the April report of The Conference Board, confirming earlier surveys by other institutions.

More important, because it is an indicator to which Larry Summers attaches considerable importance, inventories of unsold goods are down, which suggests that it won't be long before retailers and others have to re-stock, giving manufacturing a boost.

The outlook for investment in capital goods also seems to be brightening. Orders for such products designed to last more than three years--appliances and computers, for example--rose 4.3 percent in February and 1.5 percent in March (excluding volatile aircraft orders and defense spending), suggesting that we have at least reached the end of the precipitous declines of earlier months.

The GDP decline might also be less threatening than the headline '6.1 percent drop' suggests because it was driven in part by a surprising drop in spending by the federal government. Surprising because the Congress has approved the President's massive stimulus package, and late in the week his $3.5 trillion budget package--a gift to Barack Obama from Democrats in Congress eager to celebrate his first 100 days in office. It seems that the president's critics were right when they argued that the stimulus package was less designed to give the economy an immediate boost than to fund Obama's plans for greater government participation in the health care, energy and education sectors.

But the trickle of funds will soon increase, if not into a flood, then into a major flow of money into infrastructure and other projects--it has taken the states longer to get workers digging on their "shovel ready" projects than they predicted. Only two of sixteen states have agreed on how to spend all of the money they have been allocated for transportation infrastructure projects, and only three states have submitted applications for funds to enable them to avoid laying off firemen, teachers and cops. Some experts are saying that when the stimulus spending does begin to hit the streets, it will in the end freeze out private-sector spending and reduce long-term growth. But there seems little doubt that pumping $787 billion into the economy, along with other measures being taken by the Fed and the Treasury, will begin to boost the economy sooner rather than later.